Why the Great Video Game Recession Is Actually a Migration

by Anthony John Agnello | January 19, 2012 2:49 pm

Given the place that video games have occupied in mainstream consumer culture, it’s hard to believe that there isn’t greater opportunity to make a buck on them. Consider Activision Blizzard (NASDAQ:ATVI[1]). The company’s Call of Duty franchise has transformed the entertainment industry over the past four years. Perennial entries in the series–2009’s Modern Warfare 2, 2010’s Black Ops, and 2011’s Modern Warfare 3–have sold in excess of 60 million copies. New Call of Duty games are used to sell products from Pepsi (NYSE:PEP[2]) to Chrysler Jeeps. That’s to say nothing of the company’s World of Warcraft online game, which commands a base of 10 million subscribers, many paying a monthly fee of $14.99. Yet shares in ATVI have foundered around $12 for years now.

Here’s the truth about the videogame business: millions play the games, millions pay for them, but sales simply aren’t growing in the exciting ways they were just a few short years ago.

The industry’s holiday sales paint a particularly troubling portrait. According to the NPD Group, video game console sales shrank 28% year-on-year, to $1.3 billion in December, with Sony (NYSE:SNE[3]), Microsoft (NASDAQ:MSFT[4]) and Nintendo (PINK:NTDOY[5]) all seeing declines in total Playstation 3, Xbox 360, and Wii sales, respectively. Game publishers like ATVI, Time Warner‘s (NYSE:TWX[6]) Warner Bros. Interactive, Take-Two (NASDAQ:TTWO[7]), and especially Electronic Arts (NASDAQ:ERTS[8]) dominated game sales charts, but there wasn’t as much game-sales revenue to go around. It totaled just over $2 billion for the month, down 14% year-on-year.

November sales were strong enough to mitigate some of that loss–combined, retail game sales were down just 3% from 2010 across November and December–but overall, video games aren’t making what they used to at retail. Total U.S. sales across gaming machines, games, and accessories in 2008 came to $22 billion. This declined to just over $20 billion in 2009, and again in 2010, to $18.6 billion. Retail sales sank to $17 billion for 2011.

Where has all that money gone? Will it come back? Maybe. These numbers are bad but not as dire as they first look. As the Entertainment Software Association (a lobbyist group representing the games industry) reports, consumers actually spent $25 billion on videogames in 2010. The discrepancy between that number and NPD’s recorded number comes from the sale of digital goods and services online. The NPD didn’t begin tracking digital sales until earlier this year, and even then its reporting of $17 billion in total sales for 2011 reflects retail only. The virtual goods market—digital items purchased in social games like Zynga‘s (NASDAQ:ZNGA[9]) FarmVille—is expected to total $2.2 billion across 2011, while mobile games sold through digital services like Apple‘s (NASDAQ:AAPL[10]) App Store are expected to bring $5 billion in revenue for the year.

The digital market is recouping retail losses. Analysts with ABI Research expect mobile game revenue to total $16 billion by 2016. The question now is whether retail revenue will continue to retract or rebound when Microsoft, Sony, and Nintendo introduce new machines to the market over the next few years. Nintendo already plans to release the Wii’s successor, the Wii U, later this year and many industry followers expect Sony and Microsoft to introduce new devices for release in 2013.

Those consoles may not be enough, though. It’s important to remember that when U.S. video game retail sales peaked in 2008, the industry was seeing unprecedented demand for expensive accessory-based games, particularly ATVI’s Guitar Hero series. Instead of paying $60 for a game, consumers were spending upwards of $200 for plastic instrument-based music games. In 2009, Guitar Hero 3 was the first individual game to break $1 billion in sales, predominantly because of its high price tag. The market for these games has completely disappeared, however, forcing both ATVI and Viacom (NASDAQ:VIA[11]) to cancel their mutual franchises in the category. The contraction in retail sales since then is a result of changing consumer tastes as much as a shift to digital venues.

The short version for investors: Keep a close eye on the video game industry because it is going through a profound transformation. Once exciting cult stocks like ERTS and ATVI may not ever recover, but new players will emerge to take advantage of the shift. ZNGA has disappointed since making its IPO, but others in that sector won’t. For now, be wary. The sky isn’t falling, just moving.

As of this writing, Anthony John Agnello did not own a position in any of the stocks named here. Follow him on Twitter at @ajohnagnello[12] and become a fan of InvestorPlace on Facebook.